2017 was the year of the ICO’s. First, the Bitcoin rally brought blockchain technology into focus. Fundraising from companies using blockchain technology gave birth to a very interesting marketplace — that of tokens. Token economics or tokenomics intrigues me — not only because of its simplicity but also because it gets so complicated so quickly. It doesn’t take reading more than 2–3 whitepapers to realize that while the concept of tokens is quite simple, the methods companies use to evaluate them are quite different and sometimes even contradictory.
With the barrage of experts (actual and proclaimed) in the space, we strive to understand new concepts by gravitating towards explanations that make the most sense. Analogies to known concepts can help immensely in understanding new concepts because our minds like to make connections with existing ideas.
At a recent trip to a summer carnival I couldn’t help but draw parallels between carnival tickets and tokens. We bought a few carnival tickets from the ticket register and used most of them in no time. When we went to purchase a bottle of water, I scrambled through my bag only to find one ticket left. Bottled water was being sold for 2 tickets each.
‘Can I pay in cash?’ I asked, ‘I only have 1 ticket left.’
‘Nope!’ the girl at the stand replied.
‘It’s quite a walk to the ticket register, and the line is very long! Please can you take cash?’ I requested
‘No, it’s the rule, I cannot accept cash.’
A lady behind gave me an extra ticket, and I was able to purchase the bottle.
‘At least the tickets are transferable!’ the kind lady said.
Ever wondered what value do tickets provide over cash at carnivals? Why don’t carnivals use cash?
Here are a few possible explanations:
- Lines move faster with tickets because buyers don’t have to scramble for cash and sellers don’t have to give back change as the items are sold in unit number of tickets.
- By purchasing tickets, attendees commit to the carnival, as those tickets can only be used inside the carnival.
- Accounting — it becomes easier to measure which rides were popular (based on the number of tickets they accumulated).
I inquired about the same concepts on meeting a blockchain entrepreneur a few months ago:
‘Why do you need to create your own token? Why can’t your marketplace just use Ether?’
He explained that besides raising capital tokens catalyze network effects.
Positive network effects occur when the value of the network increases as more users participate in the network. When participants buy tokens, they can only use it within that token-specific network, and as they start using the services the value of the network increases. When you buy 100 tickets at a carnival, you can only use them within the carnival. As more people purchase tickets, word-of-mouth and FOMO (fear of missing out) attract more crowds. The initial purchase of 100 tickets also means that you anticipate using a minimum of 100 tickets at the fair, essentially placing a value on the carnival’s services for your afternoon.
In the scenario that the carnival printed a limited number of tickets, the price of those tickets would be dictated by supply and demand. What happens in a situation where buying a ticket from the primary issuer is not a feasible option, either due to inconvenience or scarcity? Had the kind lady not given me her ticket, I would have had to either walk to the main ticket register or purchase it from another attendee.
Scarcity combined with higher demand paves way for a secondary market. Speculators are incentivized to hoard tickets/tokens to sell to those willing to pay a higher price — in other words, the Greater Fool Theory. As explained in this article on tokenomics, when buyers hoard tickets in anticipation of prices going up, they effectively remove those tickets from circulation and dampen the positive network effects. The tickets subsequently come a vehicle for capital gain rather than being used for the purpose that they were created for.
ICO investors rely on the scarcity of tokens for the value of their investment to go up. The carnival example could be thought of as a case for utility tokens — in which the tokens are used as a medium of exchange inside the platform. However, if scalpers start hoarding tickets, they create scarcity in exchange for possible capital gains as long as the value of the carnival at least sustains its value.
While speculation raises the price of the tokens, its implications on token dynamics within the platform raises the following questions:
- Do price adjustments need to be made within the platform in response to the change in market price of the tokens? For example, if the market price of a ticket goes from $1 to $2 per ticket, should the price of the water bottle be adjusted to ½ ticket? How often do these adjustments need to be made?
- Which currencies should the price fluctuations be pegged against? Fiat or Crypto?
Networks are at the heart of the blockchain technology, and it has been interesting to see thousands of attendees come together every so often for events that act at enablers for collaboration in this space. It would be interesting to observe the dynamics if a conference implemented a carnival-type marketplace where attendees could purchase tokens during registration and use them at their favorite booths.
Token dynamics are complicated today, and while the scams are widespread, so are countless activities of community-building using the blockchain technology. Examples such as carnival tickets illustrate how such a simple concept can get murky when scarcity and speculation come into play. When the dust settles and the smoke clears, we’ll get to see who our real friends are.